THE WORLD’S EMISSIONS TRADING MARKETS

Carbon trading schemes around the world
Gerard Wynn, Timothy Gardner and Risa Maeda (w/Anthony Barker), 13 August 2009 (Reuters)

SUMMARY
The emissions trading markets already implemented around the world to cut greenhouse gas emissions (GhGs) and reverse global climate change reached a combined value of $125 billion in 2008.

According to Reuters, there are 4 such established markets: the Kyoto Protocol, the European Union Emissions Trading Scheme, the Regional Greenhouse Gas Initiative (RGGI), and Japan's voluntary carbon market.

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There are also 4 proposed trading markets: the Australian Carbon Pollution Reduction Scheme, the cap&trade system that would be created by the U.S. climate/energy change bill, the Western Climate Initiative and the New Zealand Emissions Trading Scheme.

The Kyoto Protocol grew out of the 1997 international summit on climate change at Kyoto, Japan. It became official in 2005 when 55 countries had signed it. It has now been ratified by 186 of the world’s 192 countries. The U.S. has not ratified it.

Signatories to the Kyoto agreement committed to reduce their GhGs 5% below 1990 levels by the end of the 2008-through-2012 phase. The treaty allows for individual nations to take on commitments for higher reductions.

Mechanisms through which Kyoto members buy, sell and earn emissions allowances are the carbon market, in which members trade assigned amount units (AAUs) representing a tonne (European metric ton) of carbon dioxide equivalent (CO2e), the Clean Development Mechanism (CDM), in which members trade certified emissions reductions (CERs) representing a tonne of CO2e, and the Joint Implementation (JI), in which members earn emission reduction units (ERUs) per tonne of CO2e cut.

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The European Union (EU) Emissions Trading Scheme (ETS) is an emissions trading market set up in 2005 independently of but linked to the Kyoto CDM and JI mechanisms to serve the EU in meeting its more rigorous emissions reduction goals through the purchase and sale of European Union Allowances (EUAs), each representing a tonne of CO2e. Caps on emissions and participation in the ETS are mandatory for all 27 EU member nations.

Through the ETS, some 11,000 EU GhG emitters are capped and required to obtain allowances or UN CER offsets to further emit.

The EU is currently in the process of finalizing its “triple 20” goals which aim to cut emissions 20% below 2005 levels, improve efficiency 20% and obtain 20% of its electricity from New Energy sources by 2020.

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The Regional Greenhouse Gas Initiative (RGGI) is the first mandatory U.S. trading market. 10 Northeastern and Mid-Atlantic states have voluntarily committed to cap and reduce power sector emissions 10% by 2018. RGGI holds quarterly auctions of allowances, each representing a ton of GhGs, and require power generators to hold allowances equal to their emissions.

The RGGI states held their first allowance auction in September 2008 and the first compliance period began in January 2009.

The Japanese Voluntary Emissions Trading Scheme(JVET) is designed to support Japan’s participation in the Kyoto process and its goal of cutting its emissions 6% below 2005 levels by 2012. It will operate through domestic CDM CERs and federal and municipal Japanese allowances.

Companies establish voluntary targets. Those that exceed their targets buy allowances from participants whose GhGs are below their targeted levels or fund New Energy and Energy Efficiency projects.

Operated by the Japanese Ministry of Energy, JVETS began its 4th phase in 2008. It is composed of 3 systems, a registry system, an emissions management system and a trading system. Its early phases were uniformly successful, with participants exceeding their reductions goals.

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The Australian Carbon Pollution Reduction Scheme (CPRS) is a controversial plan introduced by the recently elected Rudd Labor government. Just rejected by the Australian parliament, Prime Minister Rudd has signalled he intends to persist politically and see the plan implemented in 2011.

CPRS is a means for Australia to cut its GhGs 5-to-15% from 2000 levels by 2020 and 60% by 2050.

As described in the government’s most recent white paper, Australia would auction a major portion of its allowances from early in the program but would guard the competitiveness of its exporting businesses and industries by holding free allowances out for them and firmly holding allowance prices at 10 euros per tonne.

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In the absence of enactment of the CPRS, the Greenhouse Gas Reduction Scheme (GGAS) is the only Aussie mandatory cap&trade scheme, limiting the GhGs in the state of New South Wales to 7.27 tonnes per capita, 5% below 1990 levels, through 2021.

The New Zealand Emissions Trading Scheme aims to cut the nation’s GhGs 10-to-20% below 1990 levels by 2020 through a mandatory cap&trade system involving its power generation, transport, industrial processing, agriculture, forestry and waste sectors.

At least as controversial as Australia's CPRS, the U.S. national mandatory cap&trade plan contained in legislation passed by the House of Representatives in June calls for 17% emissions reductions by 2020 and 83% reductions by 2050. There is no certainty caps or trading will survive the Senate in the same form or at all. It would begin in 2012 with an auction of 15% of the allowances (each representing 1 ton of GhGs) and gradually ratchet the caps down and increase the percent of auctioned allowances.

The Western Climate Initiative is an alliance of 7 states (Arizona, California, Montana, New Mexico, Oregon, Utah, Washington) and 4 Canadian provinces (British Columbia, Manitoba, Ontario, Quebec) in a mandatory cap&trade system.

In the absence of a U.S. national system superceding it, participants will begin reporting emissions in 2011. The first phase of compliance begins in 2012, with a 10% auction of allowances, hard caps and trading to manage costs. Full implementation, including transportation sector emissions, will be in 2015. WCI plans to auction 25% of its allowances by 2020. The goal is a 15% reduction in emissions from 2005 levels by 2020.

Emissions trading is a compromise method of putting a price on greenhouse gas emissions (GhGs). It is an imperfect compromise, both complicated to enact and evaluate. Like any market system, it is subject to abuses. But it offers 2 advantages that no other method of emissions reduction offers: (1) Hard caps progressively ratcheted down, and (2) a trading system that (a) offers all players the opportunity not merely to suffer the burden of emissions reductions but to benefit by them, as well as (b) a method by which governments – as overseers and regulators of the system – can redistribute the revenues produced by them in the manner of a tax so as to prevent harm from coming to the least protected from the costs.

From NationalWildlife via YouTube

COMMENTARY
The pioneering achievements of the Kyoto mechanisms and the EU ETS cannot be underestimated. Based on the outline of commodities markets and the success of the limited-scale cap&trade system that ended acid rain in the U.S. in the early 1990s, these markets have, in a few short years, established themselves as meaningful efforts at emissions reductions and substantial financial platforms.

There is ongoing regulatory evolution that is certain to make regulation in the newer and larger emerging markets more effective, though markets are inherently dynamic and vulnerable to excesses and abuses, as the Fall 2008 worldwide financial meltdown and the Bernie Madoff scandal both reveal. These failures do not mean the world should or even could do away with markets.

3 points show the value of the Kyoto mechanism and ETS examples: (1) The controversial question of the percentage of allowances that should be auctioned as demonstrated in the ETS and proposed in the U.S. cap&trade system, (2) The absence of a mechanism to manage falling demand for allowances in the ETS system, and (3) Offset certification procedures for CDM CERs.

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(1) The authors of U.S. cap&trade legislation had originally designed their system with an auction of 100% of the allowances, the most revenue-maximizing and emissions-restricting way to institute such a program. Subsequent negotiations forced them to give away 85% of the allowances. It appeared they were making exactly the same kind of mistake that had led to severe allowance price fluctuations and widely-acknowledged ineffectiveness in the ETS in its earliest (2005-through-2008) period.

But unlike the ETS, which gave away more than 90% of its allowances in order to draw big European businesses and power producers into participation, the designers of the U.S. plan stopped at 85% of free allowances and include a rigid plan to ratchet down the percent of free allowances going forward. Clearly aware of the pitfalls of the ETS, the U.S. bill's authors hope to achieve the challenging compromise of giving away enough to seduce big businesses and power producers in while auctioning enough to make the system effective at financing New Energy infrastructure and forcing GhG reductions.

(2) As the ETS entered its second phase in 2008, it was becoming stable and showing signs of effectiveness when the global financial meltdown set business productivity plunging, which reduced demand for electricity, which cut the emissions businesses and power producers were generating, which eliminated their need for allowances. They fell back on banked allowances obtained for free in the ETS first phase. Demand fot allowances in the ETS market dropped sharply.

Because the ETS had been planned on the assumption of permanently rising electricity demand, the architects had only concerned themselves with building into the system a mechanism to cope with excessive allowance demand. The UN CDM’s supply of CERs was expected to be an alternative way to pay for excess emissions, working more or less in competition with the supply of EUAs to balance rising prices in both markets.

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Because there was no mechanism to cope with falling demand for and an oversupply of allowances, ETS prices plunged in early 2009. Productivity has fortunately returned, demand for allowances and EUA prices have risen and the market is returning to something approaching stability. But market regulators are already looking at ways to more effectively ratchet down the supply of free allowances in the event of another fall-off in demand.

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(3) In the first phase of the UN CDM program, developing world offset projects fell under sharp scrutiny. There were repeated charges of fraud. Projects that were being funded for their emissions reductions, it was said, would have been built anyway and were therefore not really offsetting climate change. In the wake of the controversy, the UN stopped certifying projects as CER-eligible, revised its certification processes and restarted its program at a slower pace. The result was a significant slowdown in emissions reductions.

Observing these difficulties, the authors of the U.S. cap&trade bill have set limits on how many developing world offsets can be used by its participants and established a thorough set of procedures to evaluate and certify offset projects.

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The biggest point of controversy in all the emissions trading-and-reduction systems has to do with tariffs and carbon leakage. It might at first seem to be a question of economy versus ecology. But unbalancing ecology makes an environment in which business cannot be done while unbalancing the economy has the same effect. So in the end, it is not economy versus ecology as much as it is the balancing of economy and ecology.

Domestic businesses must be provided pathways in which to thrive, to prevent them from removing to places that do not cap and charge for emissions. Tariffs must not be put on imported goods that were made at lower costs in countries without emissions caps because that violates international trade laws and would likely set off trade wars.

Yet domestic businesses must be protected from imported goods that were made at lower costs in countries without emissions caps. And all countries must eventually be brought into an international GhG-constrained regime because emissions know no borders and as long as spew goes on, everybody’s earth remains at risk.

Footnote 1: The major platforms in which allowances for these systems are traded are (1) the European Climate Exchange, (2) Nord Pool, (3) BlueNext, (4) the European Energy Exchange, (5) the New York Merchantile Exchange (NYMEX) Green Exchange, and (6) Climex.

Footnote 2: There are also a number of voluntary trading platforms, including the Chicago Climate Exchange (CCX) (the most active in North America) which is operated by the European Climate Exchange.

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QUOTES
- From the Introduction to Feeling the Heat by the United Nations Framework Convention on Climate Change:
- "The average temperature of the earth's surface has risen by 0.74 degrees C since the late 1800s. It is expected to increase by another 1.8° C to 4° C by the year 2100 - a rapid and profound change - should the necessary action not be taken. Even if the minimum predicted increase takes place, it will be larger than any century-long trend in the last 10,000 years...The principal reason for the mounting thermometer is a century and a half of industrialization: the burning of ever-greater quantities of oil, gasoline, and coal, the cutting of forests, and the practice of certain farming methods...These activities have increased the amount of "greenhouse gases" in the atmosphere, especially carbon dioxide, methane, and nitrous oxide. Such gases occur naturally - they are critical for life on earth, they keep some of the sun's warmth from reflecting back into space, and without them the world would be a cold and barren place. But in augmented and increasing quantities, they are pushing the global temperature to artificially high levels and altering the climate..."

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- From the Introduction to Feeling the Heat by the United Nations Framework Convention on Climate Change: "Climate change can be difficult - you could ask the dinosaurs, if they weren't extinct...The current warming trend is expected to cause extinctions. Numerous plant and animal species, already weakened by pollution and loss of habitat, are not expected to survive the next 100 years. Human beings, while not threatened in this way, are likely to face mounting difficulties...more frequent "extreme weather events" are on target...the sea could overflow the heavily populated coastlines of such countries as Bangladesh, cause the disappearance of some nations entirely (such as the island state of the Maldives), foul freshwater supplies for billions of people, and spur mass migrations...Drying of continental interiors, such as central Asia, the African Sahel, and the Great Plains of the United States, is also forecast. These changes could cause, at a minimum, disruptions in land use and food supply. And the range of diseases such as malaria may expand..."
- From the Introduction to Feeling the Heat by the United Nations Framework Convention on Climate Change: "Global warming is a "modern" problem - complicated, involving the entire world, tangled up with difficult issues such as poverty, economic development and population growth. Dealing with it will not be easy. Ignoring it will be worse...Over a decade ago, most countries joined an international treaty - the United Nations Framework Convention on Climate Change - to begin to consider what can be done to reduce global warming and to cope with whatever temperature increases are inevitable. More recently, a number of nations approved an addition to the treaty, called the Kyoto Protocol, which has more powerful (and legally binding) measures. The Protocol’s first commitment period began in 2008 and ends in 2012. A strong multilateral framework needs to be in place by 2009 to ensure that there is no gap between the end of the Kyoto Protocol’s first commitment period in 2012 and the entry into force of a future regime."